To Ensure the Long-Term Vitality of Mission-Driven Banks, Policymakers Should Address Barriers to Digitalization

By Nicole A. Elam, Esq., President and CEO, and Anthony Barr, Research and Impact Director, National Bankers Association (NBA)

Mission-driven banks provide capital and credit to people and places across the nation that are underserved by the broader financial ecosystem. These banks—including minority depository institutions (MDIs) and community development financial institutions (CDFIs)—help increase homeownership, support small businesses and ensure every consumer has a safe place to grow his or her savings. The very locations of these institutions illustrate their commitments to increasing financial inclusion; for example, 25 percent of MDI branches are in zip codes with no other bank present—and those zip codes are home to more than three million people.¹ But in the face of rapid technological innovation and changing business models, the long-term fate of these mission-driven banks now hangs in the balance.

The broader banking sector has grown increasingly competitive in the last several decades, and mission-driven banks face several existential threats to their long-term survival. These threats include the recent explosive growth of fintech (financial technology) firms², the entry of large retailers such as Walmart into the market³, the ongoing consolidation within the banking sector through mergers and buy-outs, and, most recently, the sharp outflow of deposits in the wake of some prominent bank failures.⁴ Mission-driven banks also face tail risks from broader revolutions in finance, including the rise of decentralized networks that can disintermediate the role of banks in storing deposits, facilitating payments and extending credit—thus forcing all financial institutions to reimagine their missions and underlying business models completely.

As we detail in our recent report, mission-driven banks need to embrace digitalization throughout all facets of their businesses to remain financially solvent in this competitive and evolving environment.⁵ Digitalization is often used as shorthand for specific features, such as automated lending, chatbots, remote check-deposit capabilities on mobile apps, and integration with third-party web applications to link bank accounts with mobile payment services. But as we explain, the underlying logic of digitalization is the ability to leverage data to streamline business practices, reduce costs, increase efficiency, enhance decision-making, improve customer experiences and provide personalization in product offerings. In its most advanced form, personalization transforms banking from a series of financial products only accessible at physical locations into banking as a service (BaaS) that can be embedded into all aspects of a consumer’s social life.

Digitalization enables banks to offer better products and services, reach broader geographies and achieve greater economies of scale—all while increasing banks’ abilities to compete. Recent research suggests, for example, that financial technology has actively lowered the costs of financial intermediation, leading to greater efficiencies.⁶ And in the context of the pandemic, FDIC (Federal Deposit Insurance Corporation) research demonstrates that banks with greater financial-technology capacities were better prepared to provide emergency capital to small businesses through the Paycheck Protection Program (PPP) relative to their peers.⁷ Each of these benefits can reinforce one another in a positive feedback loop: Leveraging data reveals opportunities for increasing efficiency, allowing banks to deploy more resources toward new loan products with better terms in new geographies. And while size matters for achieving economies of scale, even the smallest institutions can experience profound benefits from these actions.

Framed positively, therefore, digitalization represents an opportunity for mission-driven banks to expand their lending footprints and deepen their impacts. For example, Texas National Bank—a Hispanic MDI and CDFI primarily serving the Rio Grande Valley—has embraced digitalization to enhance its relationship banking model, thereby providing credit to individuals and small businesses with low credit or no collateral.⁸ Through partnerships with digital firms, the bank uses monthly inflow, outflow and overall balance information for personal and business checking and savings accounts to verify the ability to repay, thus allowing the bank to provide lending that could otherwise be ruled out as too risky. Importantly, this effort provides consumer borrowers with meaningful alternatives to predatory payday lenders, which often charge interest rates as high as 600 percent, by allowing households to deal with liquidity crunches without falling into debt traps.

Digitalization provides clear benefits for mission-driven banks and the communities they serve, but the path toward digitalization is challenging. Unfortunately, many mission-driven banks struggle to implement robust digitalization strategies due to numerous significant barriers. Our report highlights several of these barriers, including prohibitive up-front costs for platforms and services, implementation issues including current staff’s abilities and capacities, burdens from increased risk management and regulatory-compliance requirements, and deepened dependency on core providers and other third-party vendors that may not prioritize the needs of smaller clients. In addressing these challenges, mission-driven banks need the full support of the public, private and philanthropic sectors.

To empower MDIs and CDFIs on their digitalization journey, regulators and policymakers must address bottlenecks limiting growth. For regulators, the greatest need is clarity around what they should consider safe and sound practices regarding fintech partnerships and other relationships with third-party vendors. Similar guidance is required for defining what “reasonable” due diligence looks like so that banks are not left vulnerable to enforcement actions or other measures when unforeseen issues arise. Additionally, bank supervisors and regulators should allow MDIs and CDFIs to allocate more of their capital toward investing in technology and digitalization, including for use in partnerships with fintechs and other third parties.

Policymakers can support mission-driven banks by amending current provisions involving bank holding-company policies to allow publicly traded companies to make equity investments in these banks without triggering changes in ownership. These investments can, in turn, empower banks to grow their lending footprints. Policymakers should also continue to pursue new ways of driving capital into MDIs and CDFIs, including through investment and grant programs, tax credits and annual appropriations. Finally, policymakers should center mission-driven banks in future interventions similar to the Paycheck Protection Program, thereby ensuring that emergency aid is deployed to the communities most in need of it.

Beyond the government, corporate and philanthropic partners can also support mission-driven banks. These stakeholders can provide equity investments and technical assistance, loan their executives to mission-driven banks for fixed terms to help oversee the implementations of new strategies or technologies and provide access to software or other forms of technological support. In addition to funding specific deliverables, philanthropic support can include funding for capacity building and skills training to ensure that mission-driven banks can scale up the sizes and abilities of their workforces. The corporate and philanthropic sectors should seek opportunities for ongoing partnerships rather than one-time pledges, recognizing that this important work takes time to unfold.

Ultimately, we believe that mission-driven banks can lead the banking industry in applying digitalization strategies to the complex needs of 21^st-century consumers—particularly digitally native consumers in the Millennial and Gen Z generations. The journey toward digital transformation will ensure that mission-driven banks endure as anchor institutions that are further empowered in their efforts to close the racial wealth gap.

References

¹ National Bankers Association (NBA): “Minority Depository Institutions: State of Knowledge, Sector Summary & Lending Activity, and Impact, 2010 – 2022,” Anthony Barr and Mac McComas, May 30, 2023.

² CBInsights: “State Of Fintech 2021 Report,” January 25, 2022, Research Report.

³ Marketplace: “Walmart wants to be your bank,” Kristin Schwab, January 12, 2021.

⁴ Bloomberg: “US Bank Deposits Fall $76.2 Billion, Led by Large Institutions,” Alexandre Tanzi and Augusta Saraiva, April 21, 2023.

⁵ National Bankers Association (NBA): “Navigating the Digital Frontier in Banking: Challenges and Opportunities for Mission-Driven Financial Institutions,” Anthony Barr, Stephanie Thomas and Nicole Elam,April 26, 2023.

⁶ Social Science Research Network (SSRN): “On Fintech and Financial Inclusion,” Thomas Philippon,September 2019, NBER Working Paper w26330.

⁷ FDIC (Federal Deposit Insurance Corporation)/Center for Financial Research: Working Papers-2022.

⁸ American Banker: “Community bank, loan marketplace pilot transaction-based underwriting,” Miriam Cross, April 21, 2023.